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Energy market fall creates window of opportunity

Following recent severe weakness in crude oil markets, we assess key issues of supply and demand, both from a macro perspective and from a bottom-up, company-by-company perspective.

15 Jan 2015

John Coyle

Fund Manager and Global Sector Specialist

Mark Lacey

Fund Manager, Equities

Market consensus today is of a grossly-oversupplied market, exacerbated by a Saudi regime intent on inflicting damage on geopolitical rivals. In this view of the world, markets will remain oversupplied until substantial amounts of current production are forced offline, a process that could take more than 12 months. Our view is different, and here we outline the key reasons why we differ from consensus.

"The window for closing underweight positions will be short, and crude prices will be substantially higher than they are today come the end of 2015."

We expect physical crude markets will be on the turn by mid-year. They will be on the turn as demand strength will be coming through in response to lower prices. We are likely to have irrefutable evidence of a substantial supply response in both the North American shale plays and the North Sea conventional volumes by mid-year. The balances in the energy market explored in our full analysis will look very different by June. Between now and the end of June, peak weakness in physical crude markets is likely in mid-Q2 as inventory piles up in floating storage facilities. So, when will equity markets move from extreme bearishness to something less manically depressed? Our best guess is soon.

Equity investors are waiting for signs of demand strength or supply weakness, and the default position today is “big oil has yet to cut, so there is no supply response”. We expect that to change, and change in a big way, with the upcoming fourth quarter results. Capex reductions will be savage. Anyone arguing for no supply response after the Q4 updates is not listening or does not understand what is going on in boardrooms across the industry.

Of course there are risks to adding exposure to the energy sector here and we would be amiss if we ignored those risks. There are three key risks at this point in our mind. Firstly, oil demand may come up short of expectations if we have an emerging market crisis. Secondly, there is the risk that the Saudis genuinely want a price war and decide to increase production, as opposed to the current strategy of simply talking markets down. And thirdly, if US volumes prove more resilient than we expect despite savage capex cuts then that would point to prolonged weakness in oil prices.

We go into more detail in our full analysis found at the link below, but the long and the short of our argument is that we believe the window for closing underweight positions will be short, and crude prices will be substantially higher than they are today come the end of 2015.

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